Insight

The carbon price thaw: Post freeze future of GB carbon price

New analysis by Aurora Energy Research suggests that the Government faces a tough decision on the future of the UK carbon price in the upcoming Autumn Budget.

UK carbon price was instrumental in coal phase out

In April 2013, HM Treasury introduced the ‘Carbon Price Support’ – a tax paid by UK coal and gas generators. This policy has since increased UK carbon prices to £23/tonne, or nearly five times that paid in the rest of Europe.

The introduction of the Carbon Price Support was instrumental in phasing out coal generation in Britain – which fell from nearly 50% of total power generation in early 2013, to a record-low of just 2% in July 2017. For the first time since the industrial revolution, Britain saw its first hour with no coal generation on the 10th May 2016, and its first day with no coal generation on the 21st April 2017.

Analysis by Aurora indicates that the introduction of the Carbon Price Support was responsible for almost three-quarters of the decline in coal generation since 2013 – a far more significant driver than the changes in coal and gas prices over this period.

By contrast, in continental Europe, where the carbon price has been hovering around €6/tonne, coal remains a significant component of the generation mix – for example, coal and lignite power stations make up 40% of the power mix in Germany.

The Government now faces a tough decision on the future of the carbon price in the UK – and it is expected that a decision will be made in the upcoming Autumn Budget on the 22nd November.

Maintaining the UK carbon price at the current level risks a revival of coal generation in the early 2020s

In our new research report, “The carbon price thaw: Post-freeze future of the GB carbon price”, we consider a number of different scenarios for the future of the UK carbon price.

If the Government decides to maintain the carbon price at current levels, this risks a substantial increase in coal generation in the 2020s. The competitiveness of coal generation is expected to improve post 2020 relative to gas – as recent restrictions on coal production in China are eased, and the current global glut of LNG gas clears.

Cutting the UK Carbon Price Support altogether would likely result in a surge in coal generation. Our analysis suggests that if the Government gave a credible commitment to a very low carbon price, then it could become economic for coal generators to upgrade their plant and increase running hours. This would undermine the achievement of the UK’s legally binding ‘Carbon Budgets’, since coal power stations are currently the most polluting form of generation in the GB power system.

On the other hand, scrapping the Carbon Price Support would reduce total electricity costs by around £2.6 billion per annum. If all of these savings were passed on to consumers, the average household would save around £30 on their annual electricity bill.

Increasing the carbon price to over £40/tonne would align with the Governments objective to phase out coal by 2025, and help to deliver the UK’s decarbonisation plans

The Government’s stated intent is to phase out coal generation by 2025 in order to reduce domestic carbon emissions. Analysis by Aurora suggests that, given central commodity forecasts, a carbon price of around £40/tonne in 2025 would be required to phase out coal.

As well as driving out coal, higher carbon prices would also support investment in low carbon alternatives such as wind and solar. In addition, it is likely to spur investment into new interconnectors to continental Europe, which benefit from carbon price arbitrage in bringing power to the UK, leading to an increase in power imports.

This could help to deliver the carbon commitments made under the Paris agreement and the UK’s system of legally binding ‘Carbon Budgets’. Higher carbon prices would lead to a modest increase in electricity costs (£0.9bn per year, or £10 per household per year) although the accelerated buildout of renewables and interconnectors would help to set a cap on prices in the UK.

A surprising finding from our analysis is that increasing the UK Carbon Price Support to over £40/tonne would not lead to an increase in carbon taxes receipts overall, since it would result in a closure of coal power stations, eroding the tax base.

Government faces a tough decision over the future of the carbon price

The Government faces a tough decision on the future of the carbon price – balancing its competing priorities of meeting carbon targets, ensuring security of supply, delivering affordable energy to consumers, and managing tax receipts. Aurora’s analysis suggests that it would be risky for the Government to cut carbon prices – as this would lead to a surge in coal generation, making it harder to deliver our carbon budgets. At the same time, increasing the gap in carbon prices between the UK and Europe would increase consumer bills, and lead to greater imports of electricity from Europe – offshoring GB emissions elsewhere.

The full report is available to subscribers through our online platform EOS.

A summary of the report is available for non-subscribers to download here.